Is a tax hike in sight?

It won't be imminent, but if taxes have to be raised in future, bet on a hike in GST rather than an increase in personal or corporate income tax.

By Lim Gek Khim And Grahame Wright, Published The Straits Times, 18 Jan 2014

SINGAPORE is slowly, but surely, becoming a greying nation. As people live longer and have fewer babies to replace themselves, Singapore joins the ranks of Japan, China, Hong Kong and South Korea in having to deal with a swelling silver generation. At the same time, the gap between the rich and poor is widening.

The Government is already pouring millions into health care, housing and education policies, and striving to strengthen social safety nets. While Singapore has enough in its coffers for all this social spending for now, a tax hike may be inevitable in the longer run as costs escalate.

"All good things have to be paid for," as Prime Minister Lee Hsien Loong said in his 2013 National Day Rally speech.

But what would be the first in line for an increase should there be a need to raise tax revenue?

Goods and services tax (GST)

OVER the years, Singapore's government has shifted its reliance from direct taxes to indirect taxes. The GST rate has been steadily increased from 3 per cent to 7 per cent. The GST is now the second largest contributor to tax revenue in percentage terms, after corporate income tax.

Its share of the total tax revenue pie has been increasing, accounting for 21.9 per cent of total taxes collected by the Inland Revenue Authority of Singapore in the 2012/13 financial year, up from 13.1 per cent a decade ago.

This increasing reliance on indirect taxes is common among many nations, particularly in the European Union (EU). Between 2008 and 2012, the average EU standard value-added tax (VAT) - a consumption tax similar to the GST - increased from around 19.5 per cent to more than 21 per cent.

In Asia, a similar (though less explicit) trend is also observed. Japan, a developed country with a rapidly ageing population, will be hiking its consumption tax rate over the next two years - from 5 per cent to 8 per cent in April, and subsequently to 10 per cent in October next year - to raise government revenue. Malaysia has also announced its intention to implement GST from April 1 next year.

Singapore's GST rate is among the lowest in the world. Against a backdrop of rising indirect taxes globally, there is room to increase the GST in the long run.

A GST rate hike is unlikely to dent Singapore's international competitiveness (as opposed to a rise in income tax) as it is a domestic consumption tax largely borne by end consumers. Being a broad-based tax, GST allows citizens to contribute to the costs of public services. As such, it is the most suitable fiscal tool for funding social programmes.

For now, the GST rate will be maintained. In 2011, Finance Minister Tharman Shanmugaratnam had assured the GST rate would not be increased for at least the next five years.

Beyond that, it is probably a matter of when, not if, the GST will be raised.

Personal income tax

SINGAPORE'S personal income tax rate has changed only twice since 2003. Budget 2005 introduced a two-step rate reduction, while Budget 2011 generally reduced most rates, but also introduced additional income bands to stratify the middle-income tiers.

The top personal income tax rate of 20 per cent has been maintained since the Year of Assessment (YA) 2007, despite suggestions to harmonise the 3 per cent differential between the top-tier personal income tax rate and the corporate tax rate of 17 per cent.

Against this backdrop, two themes have emerged: Maintenance of a competitive edge with Hong Kong, so that the large majority of taxpayers in Singapore pay less or a similar income tax than they would if they were resident in Hong Kong; and more recently, a desire to make Singapore's individual tax system more progressive.

Given this, can individual income taxes be a potential source of revenue to pay for social safety nets and programmes?

As these social programmes are targeted at lower income earners, it would be counterintuitive to raise tax rates applicable to this same group. A rate increase applicable to the middle-income earning "sandwich class" - a group carefully considered in recent Budgets - may have a large impact, as this group has been acutely feeling the pinch of higher living costs in Singapore.

It would then appear to make more sense for the higher income earners to shoulder a greater tax burden to fund social programmes should the government choose this path. This group, however, includes the segment of the population that also currently pays more tax in Singapore than they would in Hong Kong. The competitive edge with Hong Kong will be further diminished if taxes at these highest income bands are raised.

Just how much additional tax might be raised if the top rate of 20 per cent is increased by 1 per cent or 2 per cent?

Based on YA 2012 published data, it is estimated that each 1 per cent increase in the top marginal tax rate could add $110 million to $120 million in tax revenue. This is a small fractional increase to total tax collections of $41 billion in YA 2012.

The "tax the rich" option offers little upside, yielding such a small increase in total tax revenue, but at the expense of a greater downside - a diminishing competitive edge vis-a-vis Hong Kong. This risk may not be worthwhile.

Corporate income tax

SINGAPORE'S corporate income tax rate was 40 per cent about 30 years ago. Today, this rate stands at 17 per cent. Over three decades, Singapore has steadily reduced its headline corporate tax rate by more than half to maintain a corporate income tax regime that is competitive and relevant to deal with the effects of globalisation. This coincided with a worldwide trend of nations cutting corporate taxes to reduce business costs and attract foreign direct investment.

How does Singapore's corporate income tax rate stack up, and where is it likely to head?

At 17 per cent, Singapore's corporate income tax rate is already one of the lowest in the region. Taking into account the partial tax exemption on the first $300,000 of chargeable income, the effective tax rate for most small and medium enterprises is in fact much lower. For example, the effective tax rate for a company with $500,000 of chargeable income is only 11.8 per cent.

Singapore's corporate income tax rate is already competitive for both multinationals and small and medium enterprises. We do not expect the rate to be further reduced in the near future, especially in the midst of developments surrounding the Organisation for Economic Cooperation and Development's action plan on base erosion and profit shifting.

Neither do we expect a hike in corporate tax rate. Singapore is a small country. Keeping the corporate income tax regime competitive to attract foreign direct investment is and is likely to remain a key fiscal policy focus.

Overall, we expect the corporate tax rate to be maintained at 17 per cent - at least for the next few years.

As Singapore's population ages, more will have to be done to help the needy and vulnerable. Social programmes have to be funded - and that may mean higher taxes or cuts in spending elsewhere to avoid a debt-laden future generation.

If higher taxes are on the cards, the bets will be on the GST to be raised first.

Lim Gek Khim is partner, International and Corporate Tax Services, and Grahame Wright is partner, Human Capital, at EY in Singapore. EY is a global professional services firm.